Deposits of 20% look likely to become a minimum requirement as the Reserve Bank attempts to cool the market.
Deputy governor Grant Spencer said in a speech to Business New Zealand that while limited house supply was at the heart of the problem, strong demand, supported by easy credit, was underpinning the rapid escalation of house prices.
''New mortgage approvals and loans have been growing at a faster rate and are now comparable with the pre-GFC peak levels.''
The value of house sales was now also near the 2006-07 peak.
The Reserve Bank has for some time been talking about introducing its macro-prudential tools to help moderate house price inflation.
Mr Spencer continued the theme yesterday. Of the four potential macro-prudential tools available, the loan-to-value (LVR) ratio was the one with the best scope to dampen the current strong demand for housing, as well as reducing the risk to bank balance sheets.
''While we believe that LVR restrictions could have significant benefits in terms of reducing systemic risk in the housing market, they are not a panacea. We know that LVR restrictions could introduce market distortions.''
However, the Reserve Bank needed to assess inefficiencies against the potentially significant economic and financial damage that could result from a housing boom that ended in a severe housing downturn, he said.
Most of the current housing market pressure was in Auckland and Christchurch and Mr Spencer said it was due to a combination of factors.
In Christchurch, the pressures were a direct result of the damage to the housing stock from earthquakes and the demands of the rebuild.
In Auckland, housing imbalances were the result of limited supply over several years and strong demand, supported by historically very low mortgage rates and easy credit terms. That included a willingness of banks to accept ''relatively low'' deposits.
If house prices and debt were rising from depressed levels, those trends would not be of real concern, he said.
But current house prices and debt trends were on top of already high base levels by both historical and international levels. New Zealand had the fifth-highest house price overvaluation, relative to incomes, in the OECD.
Borrowers with high LVR loans were often stretching their financial resources, paying a deposit of less than 20% and often also having high debt service ratios, Mr Spencer said.
''Such borrowers are more vulnerable to an economic or financial shock such as a recession or an increase in interest rates. High LVR loan is more likely to be under water in the event of a default and is therefore a riskier proposition for the lender.''
A restriction on the volume of high LVR loans should reduce the inherent risk in banks' mortgage portfolios, as well as reducing the overall supply of credit to the housing market, he said.
